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What dry bulk owners need to know about the internal dynamics of China

George Nordahl from Affinity Research highlights the complexity of the Chinese industrial machine, and its role in determining import demand.

Determining the true state of China’s demand for commodities, steel in particular, is a matter fraught with uncertainty and reliance on third party sources. As a result of the limited insight allowed into the inner workings of the Chinese state controlled economy, demand for goods such as steel is often inferred from the volume of imports and the perceived consumption of key ingredients and raw materials. Furthermore, published information on the capacity of steel mills, mines and refineries often lacks the detail needed to adequately asses the utilisation rate of the available capacity. In addition, the fact that China, for many commodities has the option of consuming domestic resources, though often of lesser quality than imports, means there exists a balance where a change in domestic consumption can affect the demand for imports without an increase in the underlying demand. Furthermore, both Chinese demand and production is price sensitive, as state owned producers, though heavily subsidised, remain subject to economic incentives.

This highlights some of the difficulties faced when trying to assess what the future holds for the second largest, and arguably most influential economy, in the world. Furthermore, it is in light of this that the following information must be read.

A recent study conducted by Custeel, a consultancy with ties to the China Iron and Steel Association (CISA), and Greenpeace, suggests that China’s active operational steel capacity grew in 2016, despite a series of high profile mill closures aimed at removing inefficient capacity. Last year, China shuttered a total of 85m tonnes of annual capacity, of which the study shows only 27% was operational, the rest having already been idled. In addition to this, the study suggests that despite the ban on new projects for the steel industry, 12m tonnes of annual capacity, presumably begun before the ban, began operations, while another 49m tonnes are estimated to have restarted production in light of increased steel prices. Representatives from Greenpeace related to the study have said that while gross steelmaking capacity is likely to have fallen in 2016, operational capacity is estimated to have risen to 1bn tonnes per year, from an approximate 965m tonnes.

At first sight then, using the logic laid out in the first paragraph, this seems to suggest that Chinese steel demand remains firm. Indeed, data from the National Bureau of Statistics of China shows that investment in completed fixed assets grew to RMB59.65bn in 2016, up from RMB55.16bn in 2015, indicating that China’s promise of increased infrastructure investment is being carried out and has noticeable effects on steel demand.

Then again, China’s official figures for 2015 suggested that total steel capacity stood at 1.1bn tonnes per year, of which 300m tonnes was surplus capacity. Does that mean that China has simultaneously removed enough of its inefficient capacity, while absorbing part of the existing capacity through the continued growth of the economy? Fundamentally, such balances remain very murky to the outside eye. For the shipping industry, the internal dynamics of China are of secondary importance to the total volume of import demand the country generates. Nevertheless, an understanding of the origins of such demand provides us with the clues as to when the tides will change, though for the time being, in the case of steel making ingredients, demand appears firm.

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